Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future Earnings? Evidence from Order Backlog

Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future...
Rajgopal, Shivaram; Shevlin, Terry; Venkatachalam, Mohan
2004-10-03 00:00:00
Although leading indicators are becoming increasingly important for equity valuation, disclosures of such indicators suffer from the absence of GAAP related guidance on content and presentation. We explicitly examine (i) whether one leading indicator—order backlog—predicts future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings, and a hedge strategy that exploits such overweighting generates significant future abnormal returns. However, such mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.
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Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future Earnings? Evidence from Order Backlog

Abstract

Although leading indicators are becoming increasingly important for equity valuation, disclosures of such indicators suffer from the absence of GAAP related guidance on content and presentation. We explicitly examine (i) whether one leading indicator—order backlog—predicts future earnings, and (ii) whether market participants correctly incorporate such predictive ability in determining share prices. We find that the stock market overweights the contribution of order backlog in predicting future earnings, and a hedge strategy that exploits such overweighting generates significant future abnormal returns. However, such mispricing is not due to analysts' inability to incorporate order backlog into their earnings forecasts.